If you’re getting a home loan soon, either for purchasing your first home or even refinancing an existing mortgage, you’ve probably more than gathered you’ve got plenty of options. Sometimes though just the number of financing options and choices you need to make can seem a bit overwhelming or at minimum confusing. Most consumers today do their own research online to get some basic mortgage information and in doing so discover there’s a lot more to know than simply calculating a monthly payment.
You can certainly do that but there are several other dynamics going on that will impact your mortgage both short and long term. With a home loan, once you sign your closing papers and your loan funds, it’s a done deal. You can’t go back to the settlement agent or the mortgage company and change the terms of your loan. Your terms are hard-wired into your note.
But that’s okay, we’ll sort out the basic options and explain a bit about the choices you’ll make and how that will affect your very own home loan. In general, you have a choice of getting the lowest payment or getting the lowest cost loan. Or somewhere in the middle.
Loan Terms
One of the choices you’ll need to make is the actual term of your loan. Lenders can provide you with a mortgage that is fully paid off, or amortized, in 10 years. And on most loan programs that same mortgage could be amortized over 15 years. Or 20, 25 and 30. What is the impact of your loan term?
When you shorten the term of the loan, you’re having to pay the note back more quickly which will result in higher payments. To explain that in its simplest terms, if you borrowed $350,000 and your loan term was just one year, your payments would be in the stratosphere, as in around $30,000 per month. This same principle applies to mortgage loan terms.
When you pay off a loan in 10 years, your payments will be higher compared to a loan paid off over 30 years.
Let’s look at the monthly payments for those loan terms based upon a $350,000 loan at 3.25%:
Term Payment
10 $3,420
15 $2,459
20 $1,985
25 $1,705
30 $1,523
You can easily see how the term of the loan affects the monthly payment. The 30 year term provides for the lowest cost each month while the 10 year has the highest monthly payment. But one thing shorter term loans do provide is less interest paid to the mortgage company. Here is the interest paid over the entire term of the loan using those same numbers:
Term Payment Interest
10 $3,420 $60,419
15 $2,459 $92,681
20 $1,985 $126,444
25 $1,705 $161,682
30 $1,523 $198,280
That’s just one of the tradeoffs adjusting the loan term. The highest cost loan is also the one with the lowest monthly payment in terms of long term interest paid.
Closing Costs
A common example of higher costs and lower payments is a result of paying a discount point in order to lower the interest rate on your loan. For example, using the same numbers shown above, you see the 30 year fixed rate monthly payment is $1,523.
However, your loan officer can offer you a lower rate if you agree to pay a discount point. A discount point is a form of prepaid interest to the lender and is based upon a percentage of your loan amount.
If you want to lower your rate and therefore your monthly payment, you might be offered to pay one point, equal to one percentage of your loan amount, and in exchange lower the 30 year fixed rate from 3.25% to 3.00%. That would mean paying $3,500 in points at the closing table in exchange for lowering your monthly payment from $1,523 to $1,475, or $48.
In this fashion, your costs are higher in the form of $3,500 more in closing costs but your payment is lower. There’s always a trade-off. When getting a mortgage, the mortgage company will have their own fees in addition to fees charged by third parties providing services the mortgage company needs in order to close your loan. Closing costs can’t be ignored as someone must pay for them. One way to keep your closing costs low is to have someone else pay for them. When you’re buying a home, that someone could be the seller.
When you begin to craft an offer with your agent, you can ask the seller to pay for some or all of your closing costs at the settlement table. You can ask for a specific number such as $3,000 or you can ask for an amount that is equal to a certain percentage of the sales price. Sellers are perfectly allowed to pay closing costs on your behalf up to a particular limit. In this fashion, you can keep your closing costs low and still have the option of getting the lowest monthly payment based upon the term you choose.
Yet what if the seller declines your request? Then the closing costs are your responsibility. Yet there is another option- your mortgage company can pay some or all of them for you. But not exactly in the same manner as having a seller pay them at closing.
Your loan officer can adjust your mortgage rate and in turn provide a lender credit. Just as you can lower your interest rate by 0.25% by paying one point, your lender can adjust the rate higher and provide a lender credit. If you have a 30 year rate of 3.25% and pay no points you might get a rate of 3.50% and the lender in turn provides you with a $3,500 credit toward your closing costs. You have lower costs but a higher payment.
Mortgage loans have short term costs in the form of closing fees and long term costs in the form of interest paid to the lender. Don’t just think you have two choices, a 15 and a 30 year term. There might very well be a “sweet spot” just for you with a term somewhere in the middle. Your loan officer can help with this.
